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‘Fiscal cliff’ doesn’t deter income seekers

Commentary: Money pours into dividend ETFs as higher taxes loom

By

JohnPrestbo

NEW YORK (MarketWatch) — Taxes on dividends are bound to go up next year, at least for many people. Yet investors have been flocking to dividend-focused exchange-traded funds.

Investment researcher Morningstar Inc. estimates that $89.5 billion flowed into U.S.-listed equity ETFs this year through Nov. 30, of which 10%, or $8.9 billion, was directed to ETFs with “dividend” in the name. That amounted to a 23% increase from the end of 2011 and raised total assets in dividend-focused ETFs to $48.1 billion. Read more: 3 unloved dividend stocks to watch in 2013.

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This inflow bonanza was not shared equally. Vanguard Group captured a full third of the new money. Vanguard Dividend Appreciation
VIG, -0.95%
attracted the most, raking in more than $2.1 billion, or 23.6% of the total. As a result, the ETF’s assets swelled by 22% to more than $12 billion, making it the largest dividend-oriented fund.

In second place was Vanguard High Dividend Yield Index
VYM, -0.41%
, which took in $1.5 billion, or 11% of the total, boosting the fund’s assets to $4.2 billion. Those two Vanguard funds currently hold 34% of all dividend ETF assets, according to Morningstar.

Nine dividend ETFs now have assets over $1 billion. Here is how they stack up:

Yield vs. return

The table above is revealing. First, the fund inflows don’t correlate well with the yields. The Vanguard inflow champ has the lowest yield of the lot, for example, while iShares Dow Jones Select Dividend Index Fund
DVY, -0.46%
ranked second in yield of the seven domestic funds but fourth in new money. The highest-yielding domestic ETF in this group, WisdomTree Dividend ex-Financials Fund
DTN, -0.62%
, had the smallest inflow.

Apparently, considerations other than yield are playing a role. What they might be is anybody’s guess. The implication is that investors would be wise to look beyond popularity — fund inflows or asset levels — in deciding where to put their money. Following the herd can be costly.

The table also shows underperformance — though not directly. Only one of the domestic dividend funds in this group did as well as the broad market, which rose 12.8% through Nov. 30 as measured by the Dow Jones U.S. Total Stock Market Index. The iShares High Dividend Equity Fund
HDV, -0.83%
, tracking the Morningstar Dividend Yield Focus Index, lagged the market’s return only by the amount of the management fee (0.4%).

Such performance isn’t unusual. Studies show that U.S. dividend-paying stocks outperform dividend non-payers roughly half the time. Non-payers tend to do better when the growth style and/or smaller stocks are in favor.

Income-seekers would have found that SPDR S&P International Dividend ETF
DWX, -1.18%
underperformed the market but has the fatter yield. However, both of the international funds’ yields are far plumper than those of U.S.-market dividend funds, thanks largely to last year’s slump from which international markets haven’t fully recovered.

Dividend-paying ETFs are under a cloud nowadays. There is a lot of chatter about whether higher taxes will tarnish the appeal of dividend-oriented ETFs. I don’t think that’s a worry, so long as bonds fail to deliver the income that investors seek. Investment companies seem to agree, as I count 34 dividend ETFs in registration at the SEC on the list compiled by IndexUniverse.com.

The dividend category makes sense for many investors. Just be sure the funds you pick make sense for you.

John Prestbo is retired as editor and executive director of Dow Jones Indexes, now part of S&P Dow Jones Indices, in which Dow Jones & Co., publisher of MarketWatch, holds a small interest. Radhika Uppalapati contributed research to this report.

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